Rental Property Depreciation for Tax Purposes: Basis and Recapture

Rental property depreciation is a yearly income tax deduction that lets you recover the cost of a rental building by spreading it across a fixed recovery period set by the IRS: 27.5 years for residential rentals and 39 years for commercial buildings. Land is never included because it doesn’t wear out. The deduction starts when the property is ready and available to rent, continues in equal amounts each full year, and is claimed on Form 4562 with the result flowing to Schedule E. It’s usually the biggest tax break of owning a rental, and the IRS will reduce your basis by it when you sell whether you actually claimed it or not.

What You Can Depreciate

Federal tax law allows depreciation on property that wears out over time and is used in a business or to produce income.¹ You have to own it (a mortgage is fine), it needs a useful life longer than a year, and it has to be the kind of asset that decays or becomes obsolete. Rental houses and apartment buildings qualify. Raw land never does.

Personal use eliminates the deduction. A home you live in full time isn’t depreciable. If you rent out part of your home, you can depreciate the rental portion, dividing expenses by any reasonable method — room count and square footage are the two common ones.²

Figuring Your Depreciable Basis

The depreciable basis is the dollar amount you’ll spread across the recovery period. It begins with what you paid: cash, mortgage debt, and any other consideration.³ Certain closing costs get added, including title fees, recording fees, and survey costs. Major capital improvements made before you rent it out — a new roof, a full HVAC replacement, a garage addition — also go into basis. Routine maintenance like repainting or fixing a leaky faucet doesn’t; those are deducted as expenses in the year you pay them.

Then split the land from the building. Only the building is depreciable. Most owners use the ratio between land and improvements shown on their local property tax assessment and apply that percentage to what they paid. A professional appraisal is another option and can be worth it if the tax assessment undervalues the building relative to the land. Getting this allocation right at the start prevents years of miscalculated deductions.

Converting a Personal Home to a Rental

When you stop living in a home and start renting it, your depreciable basis isn’t automatically what you paid. It’s the lesser of the property’s fair market value on the date of conversion or your adjusted basis at that time.² If you paid $300,000 but the home was worth $250,000 when you converted it, you depreciate off $250,000 (minus land), not the purchase price. Missing this rule leads to years of overclaimed depreciation.

Inherited Rental Property

If you inherit a property and rent it out, your depreciable basis is generally the fair market value on the date of the previous owner’s death rather than what they paid.⁴ This stepped-up basis usually gives you a much higher starting point. If the estate filed a federal estate tax return, you should receive a Schedule A from Form 8971 reporting the value to use.

Recovery Periods and Method

The Modified Accelerated Cost Recovery System (MACRS) sets the timeframe over which you take your deductions:

Residential rental property: 27.5 years, for any building where at least 80% of gross rental income comes from dwelling units.⁵
Nonresidential real property: 39 years, covering offices, retail space, warehouses, and other commercial buildings.⁵
Qualified improvement property: 15 years, for improvements to the interior of an existing nonresidential building (flooring, lighting, interior walls), excluding enlargements, elevators, escalators, and internal structural framework.⁵

Most individual landlords use the General Depreciation System with the straight-line method, which produces equal annual deductions in every full year of ownership. The Alternative Depreciation System (ADS) uses longer timelines: 30 years for residential rental property placed in service after 2017 and 40 years for nonresidential real property.⁵ ADS is mandatory for a few situations, including tax-exempt use property, property used predominantly outside the United States, and businesses that elect out of the Section 163(j) interest limit.⁶

Bonus Depreciation and Cost Segregation

Bonus depreciation lets you deduct a large percentage of certain property costs in the first year instead of stretching them across the full recovery period. Under the phase-down enacted in 2017, the rate was 60% in 2024, 40% in 2025, and drops to 20% in 2026. After 2026 it expires unless Congress extends it. Bonus depreciation doesn’t apply to the residential rental building itself, which stays on straight-line over 27.5 years. It does apply to shorter-lived items like appliances, carpeting, certain site improvements, and qualified improvement property inside commercial buildings.

A cost segregation study breaks a building into components and reclassifies items that qualify for shorter recovery periods, typically 5, 7, or 15 years. Common targets are light fixtures, cabinetry, specialized electrical, decorative millwork, paving, and landscaping. The studies are performed by engineers or specialized firms and aren’t cheap, but for properties around $500,000 or more the accelerated deductions in the early years often outweigh the cost. The IRS expects the work to be done by qualified professionals with construction and engineering expertise.

How to Calculate and Report the Deduction

To figure your annual deduction, you need four things: the date the property was placed in service, the depreciable basis (cost minus land plus improvements), the recovery period, and the depreciation method. Placed in service means the property was ready and available for rent, not necessarily the day a tenant moved in.

Real property uses the mid-month convention: the property is treated as placed in service at the midpoint of the month you actually started, whether that was the 3rd or the 28th.⁷ That affects only the first-year and final-year deductions; every full year in between gets the same amount.

Report the deduction on IRS Form 4562. For property placed in service during the current tax year, use Part III: enter the depreciable basis, the recovery period, the convention code (MM for mid-month), and the method code for straight-line. The result flows to Schedule E for rentals, or Schedule C if the property is used in a non-rental business.⁷ Form 4562 attaches to your Form 1040.

Whether You Can Actually Use the Loss

Depreciation often produces a paper loss — deductions bigger than the rent you collected, even though you didn’t spend that much cash. The IRS treats rental income as a passive activity for most people, and passive losses can generally only offset passive income. Your rental loss can’t automatically reduce your W-2 wages.

There’s a meaningful exception. If you actively participate in managing the rental (approving tenants, setting lease terms, authorizing repairs), you can deduct up to $25,000 of rental losses against non-passive income each year.⁸ You must own at least 10% of the property.⁹ The $25,000 allowance shrinks by $1 for every $2 your modified adjusted gross income exceeds $100,000 and disappears at $150,000. Losses you can’t use in the current year carry forward.

If real estate is your primary occupation, the passive rules may not limit you at all. To qualify as a real estate professional you must spend more than 750 hours during the year in real property businesses where you materially participate, and that time must be more than half of your total personal services across all your work.⁹ W-2 hours don’t count unless you own more than 5% of the employer. Meeting the threshold makes your rental activities no longer automatically passive, which can open unlimited loss deductions against other income. You still need to materially participate in each rental, and more than 500 hours per year on it is the cleanest way to prove that. The IRS scrutinizes these claims, so keep detailed time logs.

What Happens When You Sell

When you sell, the IRS takes back part of the benefit. The gain attributable to depreciation you claimed on the building is taxed at a maximum rate of 25%, rather than the lower long-term capital gains rates that apply to the rest of your profit.¹⁰ This is called unrecaptured Section 1250 gain.

The math is direct. Say you bought a rental for $300,000, allocated $250,000 to the building, and claimed $50,000 in total depreciation. Your adjusted basis is $250,000 ($300,000 minus $50,000). If you sell for $350,000, your gain is $100,000. The first $50,000 is taxed at up to 25%. The remaining $50,000 is taxed at your long-term capital gains rate.

The Allowed-or-Allowable Trap

When you sell, the IRS reduces your basis by the depreciation “allowed or allowable,” whichever is greater.¹¹ Even if you never claimed a single dollar of depreciation, the IRS still reduces your basis by the full amount you should have taken.¹² Skipping depreciation gives you the worst of both worlds: you miss the annual deductions and still owe the recapture tax at sale.

Fixing Missed Depreciation

If you failed to claim depreciation in prior years, you generally can’t fix it by amending old returns. Instead you file Form 3115 (Application for Change in Accounting Method), which treats moving from no depreciation to proper depreciation as a change in accounting method.¹³ Complete Schedule E of Form 3115 and use Designated Change Number 7. No user fee is required for this automatic change.

The form calculates a Section 481(a) adjustment: the total depreciation you should have claimed in all prior years. You take that catch-up deduction in a single year. Attach the original Form 3115 to your timely filed return for the year of the change and send a signed copy to the IRS National Office.¹³ Because the allowed-or-allowable rule will hit your basis at sale either way, filing Form 3115 to recover missed deductions is almost always worth doing.

Records to Keep

Keep all records tied to the property — purchase documents, closing statements, improvement receipts, and depreciation schedules — until the statute of limitations expires for the tax year in which you dispose of it.¹⁴ Since the general limitations period is three years after filing, and since your depreciation schedule runs for decades, that effectively means holding onto your purchase records and improvement documentation for the whole time you own the property and about three years after you sell. Without them, proving your basis, your depreciation, or your gain at sale is hard, and the IRS won’t reconstruct any of it for you.

1
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
2
Internal Revenue Service. Publication 527, Residential Rental Property
3
Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property; Cost
4
Internal Revenue Service. Publication 551, Basis of Assets
5
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
6
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
7
Internal Revenue Service. Instructions for Form 4562 (2025)
8
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
9
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
10
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
11
Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
12
Internal Revenue Service. Depreciation and Recapture 3
13
Internal Revenue Service. Instructions for Form 3115
14
Internal Revenue Service. How Long Should I Keep Records